Digging Out of the Bad Debt Mess

Walter Wriston, chairman of First National City Bank of New York, made an unplanned Sunday flight back from sunny Jamaica to snowy Manhattan. David Rockefeller, chairman of Chase Manhattan Bank, returned from a stay in Maine and immediately got on the phone in his elegant New York town house.

Both felt they had to draft immediate statements rebutting the scary implications of a story in the Washington Post. Under a headline that sprawled across six columns of the front page, the Post reported that Citibank and Chase had landed on a list kept by the Comptroller of the Currency, a chief U.S. banking regulator, of "problem" banks. Reason: they held a relatively large volume of questionable loans in relation to the capital they had on hand to cushion potential losses. That merited a closer-than-normal watch over their operations by regulators.

Wriston termed the Post story "the moral equivalent of publishing raw data from an outdated FBI file." He insisted that Citi bank's condition is "excellent." Rockefeller called the story "a clear case of irresponsible journalism" and asserted that Chase is "sound, vital and profitable." Comptroller of the Currency James E. Smith noted that all the in formation was taken from outdated reports some l l/2 years old. Both banks have had subsequent inspections and, except for the loan losses, they apparently more than satisfied the examiners. The banks, said Smith, "continue to be among the soundest banking institutions in the world." The Post it self pointed out that neither Citibank nor Chase faces "any immediate financial difficulties." It is believed that the information was leaked to the Post by a low-ranking official with access to the reports. Disclosing the results of a federal examiner's bank report to a newspaper or anyone else is illegal.

But though the Post story was vastly overplayed and gave little perspective, it did touch on real concerns with in the banking community. The comptroller's office no longer keeps the list that the newspaper described, but it did until sometime last year. Citi bank, the second largest U.S. bank, and Chase, the third largest, really had been on the list. And the fact that two such giants could have been deemed in need of extra regulatory attention illustrates the pervasive na ture of some genuine troubles in the nation's banking system. Collectively, the 14,600 U.S. commercial banks are writing off a record number of loans as uncollectible bad debts -- an estimated $3 billion for 1975, or 50% more than in 1974 and triple the loan losses of 1973. That write-off figure is not as alarming as it seems considering that as of the end of November, large U.S. commercial banks had a total of $1 19 billion in major loans outstanding. But these losses are eating into profits of banks large and small, including Citi bank and Chase. Some big banks are even reducing dividends paid to their stockholders, a fairly rare occurrence.

None of this poses the smallest threat to the system's solvency. No major bank failures are expected; banks will be able to meet their loan commitments, and the hundreds of billions of dollars that savers have deposited in them are in no danger what ever (see box). But many banks will be more careful in extending new loans, and so some consumers and businesses, especially those with less-than-top credit ratings, will be unable to borrow as much as they want. Indeed, for the banking system as a whole, the current troubles have brought a pause after a dec ade of pell-mell expansion and diversification in which Citi bank and its aggressive, caustically droll Chairman Wriston led the way. The outlook now is for several years of more cautious policies -- and tighter Government supervision.

These and other problems are scheduled for public airing on Capitol Hill in the wake of the Washington Post story. Wisconsin Democrat William Proxmire, chairman of the Senate Banking Com mittee, has announced that he will call Comptroller Smith to testify about what Proxmire called the comptrol ler's "failure to do a vigorous enough job on bank regulation." In the House, New York Democrat Benjamin S. Rosenthal, chairman of a Government operations subcommittee, will hold hearings this week on the adequacy of federal examinations of banks. He plans to call representatives of the comptroller's office, Citibank and Chase. At week's end the banks pro tested that federal regulations precluded their officers from testifying.

In any case, no hearings are needed to document the banking sys tem's difficulties. That is being done by the earnings reports of the banks themselves. These make clear that the banks are suffering a financial hangover from the recession, which left many borrowers unable to repay their debts, and also from the banks' own past vigorous push to make loans, some of which were questionable in the first place.

Though loan-loss figures for 1975 will not be complete for a few weeks, those now available are striking. Citibank in December disclosed that it would write off a record $310 million in bad debts for 1975, considerably more than double the $116.9 million in gross loan losses in 1974. Chase in the first nine months of last year wrote off $209.7 million, v. $64.5 million in the same period a year earlier. San Francisco-based Bank of America, the biggest of all U.S. banks, wrote off only a relatively small $78 million in bad loans for the first nine months of 1975. Even so, Bank of America and the seven largest New York banks collectively swallowed $737 million in bad debts during that period, nearly 31/2 times the $215 million total a year earlier.

Loan losses unquestionably will continue heavy through 1976 too, but the experts are divided over whether they will be higher than in 1975. Despite the write-offs so far, banks have a huge backlog of dubious loans still carried on their books. The biggest losses are coming on loans to real estate investment trusts--companies that sprang up in the 1960s to get in on the building boom by financing builders of shopping centers, apartments and other commercial projects. Many banks, including Chase, organized their own REITS--a move that now seems to have been most unwise. As demand for commercial construction collapsed, many builders and property owners were forced into bankruptcy, and the REITS and the banks that they borrowed from were left holding the bag. Collectively the RElTs owe banks about $11 billion--much of which will be repaid slowly and at lower-than-expected interest rates, if at all.

Another source of concern is the $14 billion or so that U.S.

banks have lent to developing countries or their agencies. Many of these countries have been hit by rising import bills for oil, while their revenues from exports of raw materials are tumbling because of worldwide recession.

Zaire, which has been hurt by a drop in the world price of its chief export, copper, recently fell months behind in paying off the $1 billion it owes to U.S. private banks and has only lately caught up with the help of the International Monetary Fund. Other copper exporters, including Zambia, Chile and Peru, might seek extensions of their loans. Bankers emphasize that a stretchout of repayment schedules by no means implies that the loans will eventually go into default, but the banks will have to wait to get their money back.

Some experts are also worried about the $17 billion or so in bank loans to companies that pledged oil tankers as collateral. Petroleum shipments are still being held down by the lingering effects of recession, the spot market price for tanker charters has plummeted, and construction of new tankers has all but ceased. If the loans go bad, the banks will be left to dispose of vessels that probably will not bring nearly a high enough price to repay the loans. Finally, bank holdings of municipal notes and securities, especially those of New York City, have fallen sharply in market value.

Thus if they do not want to sell at a heavy loss, the banks must hold the securities until they are redeemed at full value.

Investors had long taken it for granted that bank profits would go up at least moderately every year. No more: the profit record has turned spotty. Some banks are still increasing their earnings; Bank of America raised its profits in 1975 by 17%. Citibank's earnings for all 1975 will be up about 10%, but the bank recently disclosed that for the fourth quarter it will report its first decline from a year earlier since 1969. Chase in the third quarter reported earnings a stunning 56% below those for the 1974 period, and New York's Marine Midland, after clearing its books of $25 million in bad debts, expects to report an actual overall loss for the fourth quarter. Marine Midland will also reduce its dividend from 450 a share to 200.

For all these woes, banks have made substantial progress in rebuilding their capital reserves from the days of late 1974 and early 1975, when the collapses of Franklin National and Security National in New York triggered now forgotten fears about the essential soundness of the system. The buildup in reserves will probably continue. Total bank loans are expected to rise strongly during 1976, if only because economic recovery will stir more demand for credit and the Federal Reserve Board will increase the nation's money supply enough to meet that demand. But caution and quality, rather than hot pursuit of growth opportunities, are the banks' new watchwords.

Says D. Thomas Trigg, chairman of the Shawmut Association, a holding company for eight Massachusetts banks: "There will be more people paying more than the prime rate [the lowest interest charge on loans to top customers], and the margins over the prime will be greater also. Marginal credit situations are going to look a little more marginal for a while." Richard P. Cooley, president of Wells Fargo Bank in San Francisco, adds: "All banks will be more cautious, very quality conscious. No one is going to reach to make loans."

The most trouble in getting loans will be experienced by entrepreneurs who head young companies with no record of proifit growth--even if they have promising ideas. Some bankers themselves are concerned that this is an unhealthy trend for a capitalist economy that relies heavily on entrepreneurs to introduce new products and services, but they see no alternatives. One Philadelphia banker adds that even an established local manufacturer with a record of perhaps ten years of profitable operation may have difficulty in borrowing. If such a manufacturer seeks a loan to expand, says the banker, "we will want to make sure he won't wind up with excess capacity."

The new caution extends beyond loan policy. Most bank managers have ceased, at least temporarily, their ardent pursuit of the Great God Growth. Expansion in the U.S. and abroad and diversification into other businesses have drastically slowed at almost all banks. As far back as a year ago, A.W. Clausen, head of Bank of America, warned his fellow bankers: "Recent rates of growth can be sustained only at a possible risk of eroding future strength and stability." Now J. Richard Fredericks, a bank analyst in San Francisco, puts it more pithily: "Gogo banking has had it."

The go-go era began in the late 1950s and early '60s, with the rise of a generation of bankers unscarred by memories of the Depression's banking disasters. They were determined to fill profitably the ravenous demand for credit aroused by America's postwar affluence. Banks opened new branches wherever the hodgepodge of federal and state regulations permitted; between 1965 and 1975 the number of U.S. commercial banking locations exploded from 15,756 to 29,223.

In their zeal to stir up consumer business, banks resorted to all kinds of gimmicks: drive-in branches, banking by mail, extended hours. Prizes ranging from alarm clocks to television sets were offered to people who opened a new savings account. They held contests and saturated the home screen with come-on promotions. Big city and regional banks also expanded into Europe, Asia and Latin America, initially in order to serve U.S.-based multinational companies but later to provide a full range of banking services.

In the early 1960s, banks further began to concentrate on "liability management"--the concept of borrowing money to relend it at a higher rate. Citibank developed the negotiable certificate of deposit--a security that offers higher-than-usual interest to a corporation or individual investor willing to leave money in the bank for a fixed period, such as one year. If an investor wants his money back sooner, he can sell the CD to someone else. Formally, the money is a deposit; actually, it is a loan to the bank. Banks also began borrowing from the huge pool of Eurodollars held abroad, and resorted more and more to borrowing each other's excess reserves, called federal funds.

Often the banks borrowed money for a short time and reloaned it to customers for much longer periods--forcing themselves to borrow ever more heavily to keep financing their new loans.

The final push for the new banking began in the late 1960s, when bankers discovered a way to diversify. They organized holding companies, each of which took over a bank and then launched into businesses that the bank itself was legally forbidden to enter: leasing of airplanes, trucks and vending machines, purchase of consumer-loan, management consulting and real-estate development companies. Meanwhile, bank representatives competed in scouring the country for customers. Says Rutgers University Professor Paul Nadler: "Everyone was on a drunken kick. Banking became a high-volume, low-markup business."

Nadler's comments are overly harsh: the new bankers promoted more economic growth than the legendary gimlet-eyed banker of old, who would grant a loan only to a borrower who could prove that he did not need one. That, at least, is the central argument of Walter Wriston, the strongest champion and exemplar of the new banking. Under Wriston, Citibank has led in international expansion, computerization and the use of large CDs, and it was one of the first to appreciate the diversification possibilities of holding companies. (Citibank today is officially a subsidiary of Citicorp, a holding company also headed by Wriston, which is involved in mortgage banking, leasing and financial consulting, and runs 148 consumer-loan offices in 19 states through its Nationwide Financial Services Corp.) During the 1970s, Citibank has moved from third to second largest bank in the U.S. in terms of assets, elbowing past its traditional rival Chase. There are persistent rumors that some Chase directors are unhappy and would not be sorry to see Chairman Rockefeller leave--though there is no indication that he will. Wriston's reputation, in contrast, continues to grow even among bankers who are made nervous by his expansion-mindedness.

Citibank is still innovating, currently most aggressively in electronic banking--a field that gives promise of eventually creating a "checkless society," in which funds are switched easily and automatically from one account to another. While that prospect is far in the future, the bank's Citicard system is spurring some interesting changes right now.

Basically, the system is composed of a central computer tied to myriad terminals. When an encoded Citicard is inserted into one of the terminals and buttons are pressed in a given order, the terminal can get various sorts of information from the central computer and quickly and cheaply perform a wide range of transactions. The card was introduced in late 1973 to speed up check cashing. Tellers popped customers' cards into terminals and instantly verified whether the account held enough money to cover the check.

In early 1974 "Citicard Centers" appeared. That is a fancy name for small terminals spotted about a bank branch; by inserting their Citicards, customers can get information about their accounts without bothering to walk up to a teller's window. Within months the terminals were set up in department stores and other retail outlets to enable bank customers to pay for their purchases with personal checks that the merchant could quickly verify. Today Citibank has terminals in more than 2,500 retail outlets, 120 of them across the state line in New Jersey, where it is legally forbidden to open a branch (federal law forbids interstate branching). About 60 banks around the country have followed Citibank's lead and established similar systems.

Obviously, terminals offer banks a way to establish nationwide networks of services. Terminals can be located in stores and shops anywhere and are capable of handling almost all consumer transactions, including deposits and withdrawals, without requiring the customer ever to enter the bank. Legal fights started by small banking interests in Illinois, Colorado and elsewhere will delay the spread of electronic banking, but probably not stop it. Currency Comptroller Smith has already ruled that terminals located within 50 miles of a bank should not legally be considered branches. Thus Citibank once again is in the forefront of expansion, this time riding what could be the most significant banking trend of the century.

In the forefront of expansion is exactly where Wriston intends to keep Citibank. Today, while other bankers talk of retrenchment and caution, Wriston clings to his goal of a 15% profit growth each year (an aim that Citibank did not quite achieve in 1975). Many bankers believe that such a target is more appropriate for a growth company like IBM or Xerox than for a bank, which has the primary responsibility of safeguarding depositors' money. Wriston concedes that rapid expansion may increase bad-loan write-offs, but makes two arguments for doing it nonetheless. Says he: "If we didn't want any loan losses tomorrow, theoretically I suppose we could pull out of all marginal situations. But I don't think that would be very good for society." Anyway, he argues, the big question is not how large the loan losses are but whether banks are capable of handling the risk--&"and the answer to that is yes."

For Citibank, that undoubtedly is the answer. But if Wriston and his bank can prosper in the hectic world of go-go banking, some other banks clearly cannot. Overexpansion contributed heavily to the spectacular Franklin National collapse, and lately regulators have been getting chary of how much expansion they will permit. In 1974 the Federal Reserve Board forbade Bank of America to acquire a Swiss insurance company, and in December it refused Citibank permission to acquire three small finance companies in Iowa--a setback that Wriston and his aides shrug off as unimportant.

Perhaps--but these moves foreshadow a much i tougher approach by the s regulators, after a long period when banking prosperity had lulled them into complacency.

Yet the regulators' efforts are weakened by a crazy-quilt system that Federal Reserve Board Chairman Arthur Burns, himself a key bank regulator, has called "a jurisdictional tangle that boggles the mind."

At present, banks that are chartered by the Federal Government are regulated primarily by the Comptroller of the Currency --but they also must join the Federal Reserve System and abide by its rules. State-chartered banks have a choice: they can join the Federal Reserve System and accept its regulation, or they can stay outside--in which case they are regulated by state banking authorities and, in part, by the Federal Deposit Insurance Corp.

Practices that might pass muster with one agency would be frowned on by another; not surprisingly, banks have been known to switch their charters from state to federal or vice versa, thereby in effect choosing their regulators. The system is supposed to foster healthy competition among regulators, but Burns has said that it sometimes leads only to a "competition in laxity."

Lately, pressure has been building in Congress to consolidate most bank regulation into one agency. Theoretically, the Comptroller's Office, the Federal Reserve and the FDIC all go along but, as might be expected, each has a plan to streamline the system without cutting into its own role. Generally, bankers oppose any major change, on the ground that a central agency would be too rigid and inflexible. Many Congressmen disagree. The House Banking Committee has instituted a massive study called Financial Institutions in the Nation's Economy (FINE). The study's chief economist, James Pierce, advances the idea of creating a single new agency that would demand far more public disclosure of a bank's inner workings than is now required, thus enabling investors and depositors to discipline a poorly run bank by switching their money to a better-managed one.

However the argument comes out, many experts now agree that banks must reconcile themselves to much tighter Government regulation of all phases of their operations. Just how close that supervision will be depends to a great extent on how much responsibility bank managers display in handling what is, after all, the public's money.

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